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Persistent Appreciations and Overshooting: A Normative Analysis

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  • Ricardo J. Caballero
  • Guido Lorenzoni

Abstract

Most economies experience episodes of persistent real exchange rate appreciations, when the question arises whether there is a need for intervention to protect the export sector. In this paper we present a model of irreversible destruction where exchange rate intervention may be justified if the export sector is financially constrained. However the criterion for intervention is not whether there are bankruptcies or not, but whether these can cause a large exchange rate overshooting once the factors behind the appreciation subside. The optimal policy includes ex-ante and ex-post interventions. Ex-ante (i.e., during the appreciation phase) interventions have limited effects if the financial resources in the export sector are relatively abundant. In this case the bulk of the intervention takes place ex-post, and is concentrated in the first period of the depreciation phase. In contrast, if the financial constraint in the export sector is tight, the policy is shifted toward ex-ante intervention and it is optimal to lean against the appreciation. On the methodological front, we develop a framework to study optimal dynamic interventions in economies with financially constrained agents.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 13077.

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Date of creation: May 2007
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Publication status: published as Ricardo J Caballero & Guido Lorenzoni, 2014. "Persistent Appreciations and Overshooting: A Normative Analysis," IMF Economic Review, Palgrave Macmillan, vol. 62(1), pages 1-47, April.
Handle: RePEc:nbr:nberwo:13077

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  1. Caballero, Ricardo J. & Krishnamurthy, Arvind, 2001. "International and domestic collateral constraints in a model of emerging market crises," Journal of Monetary Economics, Elsevier, vol. 48(3), pages 513-548, December.
  2. Aghion, Philippe & Bacchetta, Philippe & Rancière, Romain & Rogoff, Kenneth, 2006. "Exchange Rate Volatility and Productivity Growth: The Role of Financial Development," CEPR Discussion Papers 5629, C.E.P.R. Discussion Papers.
  3. Guido Lorenzoni, 2007. "Inefficient Credit Booms," NBER Working Papers 13639, National Bureau of Economic Research, Inc.
  4. Ariel Burstein & Martin Eichenbaum & Sergio Rebelo, 2004. "Large Devaluations and the Real Exchange Rate," NBER Working Papers 10986, National Bureau of Economic Research, Inc.
  5. Tsyvinski, Aleh & Golosov, Mikhail & Farhi, Emmanuel, 2009. "A Theory of Liquidity and Regulation of Financial Intermediation," Scholarly Articles 4481504, Harvard University Department of Economics.
  6. Thomas Chaney, 2013. "Liquidity Constrained Exporters," NBER Working Papers 19170, National Bureau of Economic Research, Inc.
  7. Hausmann, Ricardo & Panizza, Ugo & Rigobon, Roberto, 2006. "The long-run volatility puzzle of the real exchange rate," Journal of International Money and Finance, Elsevier, vol. 25(1), pages 93-124, February.
  8. Pierre-Olivier Gourinchas & Rodrigo Valdes & Oscar Landerretche, 2001. "Lending Booms: Latin America and the World," JOURNAL OF LACEA ECONOMIA, LACEA - LATIN AMERICAN AND CARIBBEAN ECONOMIC ASSOCIATION.
  9. Aghion, Philippe & Bacchetta, Philippe & Banerjee, Abhijit, 2004. "Financial development and the instability of open economies," Journal of Monetary Economics, Elsevier, vol. 51(6), pages 1077-1106, September.
  10. van Wijnbergen, Sweder J G, 1984. "The 'Dutch Disease': A Disease after All?," Economic Journal, Royal Economic Society, vol. 94(373), pages 41-55, March.
  11. Krugman, Paul, 1987. "The narrow moving band, the Dutch disease, and the competitive consequences of Mrs. Thatcher : Notes on trade in the presence of dynamic scale economies," Journal of Development Economics, Elsevier, vol. 27(1-2), pages 41-55, October.
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  13. Ilan Goldfajn & Rodrigo O. ValdŽs, 1999. "The Aftermath Of Appreciations," The Quarterly Journal of Economics, MIT Press, vol. 114(1), pages 229-262, February.
  14. Ricardo Caballero & Arvind Krishnamurthy, 2001. "Smoothing Sudden Stops," NBER Working Papers 8427, National Bureau of Economic Research, Inc.
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Cited by:
  1. Frankel, Jeffrey & Smit, Ben & Sturzenegger, Federico, 2007. "South Africa: Macroeconomic Challenges after a Decade of Success," Working Paper Series rwp07-021, Harvard University, John F. Kennedy School of Government.
  2. repec:dgr:uvatin:2011068 is not listed on IDEAS
  3. Gian-Maria Milesi-Ferretti & Olivier J. Blanchard, 2011. "(Why) Should Current Account Balances Be Reduced?," IMF Staff Discussion Notes 11/03, International Monetary Fund.
  4. Rod Tyers & Lucy Rees, 2008. "Service Oligopolies and Australia's Economy-Wide Performance," ANU Working Papers in Economics and Econometrics 2008-490, Australian National University, College of Business and Economics, School of Economics.
  5. Smith, Constance E., 2011. "External balance adjustment: An intra-national and international comparison," Journal of International Money and Finance, Elsevier, vol. 30(6), pages 1195-1213, October.
  6. Olivier Jeanne, 2014. "Macroprudential Policies in a Global Perspective," IMES Discussion Paper Series 14-E-01, Institute for Monetary and Economic Studies, Bank of Japan.
  7. Nicolás Magud & Sebastián Sosa, 2013. "When And Why Worry About Real Exchange Rate Appreciation? The Missing Link Between Dutch Disease And Growth," Journal of International Commerce, Economics and Policy (JICEP), World Scientific Publishing Co. Pte. Ltd., vol. 4(02), pages 1350009-1-1.
  8. Daniel Lederman & William F. Maloney, 2012. "Does What You Export Matter? In Search of Empirical Guidance for Industrial Policies," World Bank Publications, The World Bank, number 9371, October.
  9. Cherif, Reda, 2013. "The Dutch disease and the technological gap," Journal of Development Economics, Elsevier, vol. 101(C), pages 248-255.
  10. Adriana Soares Sales & João Barata Ribeiro Blanco Barroso, 2012. "Coping with a Complex Global Environment: a Brazilian perspective on emerging market issues," Working Papers Series 292, Central Bank of Brazil, Research Department.
  11. repec:dgr:uvatin:2010002 is not listed on IDEAS
  12. Jeffrey Frankel, 2007. "On the Rand: Determinants of the South African Exchange Rate," NBER Working Papers 13050, National Bureau of Economic Research, Inc.
  13. Raddatz, Claudio, 2011. "Over the hedge : exchange rate volatility, commodity price correlations, and the structure of trade," Policy Research Working Paper Series 5590, The World Bank.

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